Self-Regulatory Organizations; Notice of Filing of Proposed Rule Change by National Association of Securities Dealers, Inc. Relating to NAqcess System and Accompanying Rules of Fair Practice
Federal RegisterDec 8, 1995
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-36548; File No. SR-NASD-95-42]
Self-Regulatory Organizations; Notice of Filing of Proposed Rule
Change by National Association of Securities Dealers, Inc. Relating to
NAqcess System and Accompanying Rules of Fair Practice
December 1, 1995.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act''),1 notice is hereby given that on November 9, 1995, the
National Association of Securities Dealers, Inc. (``NASD'' or
``Association'') filed with the Securities and Exchange Commission
(``SEC'' or ``Commission'') the proposed rule change as described in
Items I, II and III below, which Items have been prepared by the NASD.
The Commission is publishing this notice to solicit comments on the
proposed rule change from interested persons.
\1\ 15 U.S.C. 78s(b)(1) (1988).
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I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change
Pursuant to Section 19(b)(1) of the Act, attached as Exhibit A is
the full text of a series of proposed rule changes by the NASD and The
Nasdaq Stock Market, Inc. (``Nasdaq'') regarding the operation of The
Nasdaq Stock Market's NAqcess system, a new system that offers
nationwide limit order protection and price improvement 2 over the
dealer quotation of small-sized customer orders. The ``Rules of
Operation and Procedures for NAqcess'' (``NAqcess Rules'') will replace
in its entirety the ``Rules of Practice and Procedures for the Small
Order Execution System'' (``SOES Rules''), which the NASD proposes to
withdraw simultaneously with the new system becoming operational. The
NAqcess system rules package attached in Exhibit A is new and
accordingly has not been italicized. The NASD is also proposing several
new Interpretations and a new Rule in its Rules of Fair Practice to
afford individual investors the opportunity to determine whether their
orders are to be handled in NAqcess and to provide customer limit
orders held in NAqcess or elsewhere with enhanced price protection
(Exhibit B). The NASD is also proposing conforming modifications to the
NASD Manual, including the Rules of Practice and Procedure for the
Automated Confirmation Transaction Service (``ACT Rules'') and Schedule
D to the NASD By-Laws (and all other places in the Manual that refer to
SOES) to delete references to SOES and/or the SOES Rules and to replace
those references with NAqcess and/or the NAqcess Rules, as appropriate.
These references may be found in the ACT Rules, Section (c)(2); in
Schedule D, Part V, Section (1)(f), Section (7)(a), Section (8)(c), and
Section (9); and Schedule D, Part XI, Section (2)(e)(1).
\2\ Commission Note: The NASD's use of the term ``price
improvement'' in this proposal differs from the use of the term in
recent Commission releases. Specifically, the Commission has used
the term when referring to the opportunity to receive a price that
is superior to best bid or offer. See, e.g., 17 CFR 11Ac1-3(a)(2);
Securities Exchange Act Release No. 34902 (Oct. 27, 1994), 59 FR
55006 (Nov. 2, 1994) at text accompanying n. 32. The NASD's use of
the term in this proposal, on the other hand, refers to the
opportunity to receive a price that is better than the best market
maker quotation, which may not be the best bid or offer to the
extent NAqcess limit orders are included. In its recent rule
proposal concerning the obligations of market makers executing
customer orders, the Commission asked for comment on whether
automated systems that include the possibility of the interaction of
market orders with limit orders should be deemed to satisfy the
proposal's requirement that market orders be provided with an
opportunity for price improvement. Securities Exchange Act Release
No. 36310 (Sept. 29, 1995), 60 FR 52792 (Oct. 10, 1995).
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II. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
In its filing with the Commission, the NASD included statements
concerning the purpose of and basis for the proposed rule change and
discussed any comments it received on the proposed rule change. The
text of these statements may be examined at the places specified in
Item IV below. The NASD has prepared summaries, set forth in Sections
(A), (B), and (C) below, of the most significant aspects of such
statements.
(A) Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
1. Introduction
The NASD and The Nasdaq Stock Market, Inc. are proposing rules of
operation and procedure and companion rules for a new service that
provides investors market-wide price protection of their limit orders,
the opportunity to obtain price improvement over the dealer quotation
in buying and selling Nasdaq stocks, and increased access to the Nasdaq
market. The new facility, to be named NAqcess and operated by The
Nasdaq Stock Market, will permit significant opportunity for investors
in Nasdaq securities to enter limit orders inside the Nasdaq dealer
quotation and enhance the opportunity for such investors to receive
executions between the best dealer bid and offer without such orders
interacting with market makers. The limit orders at the top of the
NAqcess limit order file that are the same as or better than the best
dealer quotations will be included in the inside market for The Nasdaq
Stock Market, thereby providing new levels of transparency, increased
price efficiency, and greater investor protection. Further, the
companion rule and Interpretations accompanying the new system will
provide retail customers with enhanced price protection of their limit
orders, a significant expansion over current limit order protection
afforded to customers in the Nasdaq market. Finally, NAqcess will
provide customers that choose to enter market orders into the system
with the opportunity to obtain price improvement over the dealer
quotation through interaction with customer limit orders in the NAqcess
file and will provide a prompt, cost-effective execution at the best
price available in the market at any particular point in time.
NAqcess and the accompanying new Rules of Fair Practice provide
multiple benefits to retail investors that were heretofore unavailable
to such investors. A key feature of NAqcess that is a significant
enhancement over current practices in Nasdaq is the ability of
investors to have limit orders placed in a central file where they can
interact directly with other customer limit orders and market orders
entered into the system. Under a proposed new Interpretation to Article
III, Section 1 of the Rules of Fair Practice, a customer may instruct
its broker-dealer to enter the customer's limit order or market order
into NAqcess. Moreover, NAqcess will provide increased transparency of
the best priced limit orders in NAqcess because Nasdaq will incorporate
into the Nasdaq inside market limit orders that are priced the same as
or better than the best dealer bid and offer displayed in Nasdaq, and
their aggregate sizes in a particular security. This increased
transparency will enhance the Nasdaq price discovery process. NAqcess
will match incoming limit and market orders against limit orders
resident in the
[[Page 63093]]
NAqcess file so as to permit customer orders to interact directly with
each other without the participation of a market maker. The interaction
of customer orders offers such orders an opportunity for price
improvement over the dealer quotation and increases the likelihood that
public limit orders will be executed on a more timely basis.
The companion rules and Interpretations regarding price protection
in Nasdaq will also significantly enhance the protection of customer
limit orders whether they are held in NAqcess or stored in a member
firm's limit order file. Under a newly proposed rule, NASD member
firms, whether acting as principal or agent, will not be permitted to
execute an order at a price inferior to any limit order(s) in the
NAqcess limit order file that the member firm is able to view, without
satisfying the viewable limit order(s). An ``inferior price'' means an
execution price that is lower than a buy limit order or higher than a
sell limit order. In addition, if a member firm holds a customer limit
order outside of NAqcess, a new Interpretation to Article III, Section
1 of the Rules of Fair Practice would require the member firm that
holds the limit order to provide the customer with price protection
that is equivalent to that which the limit order would have received if
it had been entered into the NAqcess file. The concept of equivalent
price protection is further explained below.
Aside from these major regulatory enhancements that provide for
major changes in order handling and protection in The Nasdaq Stock
Market, the NAqcess system itself represents a significant improvement
over the current methodology for the handling of small investor orders.
NAqcess, as noted, will permit interaction of small customer limit and
market orders within the dealer spread and thus permit such orders to
obtain significant opportunities for price improvement over the dealer
quotation.
This new order delivery and execution system will replace SOES, the
NASD's current system for the handling of small customer orders.
Because SOES is an automated, quote-based execution system, it does not
offer the opportunity for price improvement over the dealer quotation
of small customer orders. Moreover, the proposed NAqcess system
addresses the queuing concerns that were raised in connection with the
previously proposed NProve system. NAqcess will distribute non-
directed market orders that can not be immediately matched against
NAqcess limit orders to available market makers at the inside market as
the orders are presented. A market maker will provide such order an
automated execution at the inside if the market maker presented with
the order does not manually decline the order within a 20-second period
because the market maker (consistent with SEC Rule 11Ac1-1) 3 has
already effected, or is in the process of effecting an execution in the
security and is in the process of updating its quotation. This approach
eliminates the single-threaded distribution mechanism proposed in
Notice To Members 95-20 and permits rapid distribution of orders to
market makers as the orders are received.4
\3\ 17 CFR 240.11Ac1-1 (1995).
\4\ The NASD believes that significant queues in excess of those
currently experienced under SOES today will not occur under the new
proposal. First, if the limit order file for a security has depth,
market orders will immediately execute against limit orders without
any delay. Because each order when received is immediately
distributed to the next available market maker, the large majority
of orders will be executed within 20 seconds of distribution. Even
if an order is declined by a market maker at one price level, an
event that the NASD believes will not be frequent, the declined
order will be automatically executed without the possibility of
rejection immediately upon presentation at the next price level. All
of these techniques mean that it will be rare for an order not to be
executed within a 20 to 40-second period after processing.
For example, assume that five market orders are entered into
NAqcess at one second apart from each other and there are five
market makers in the stock at the inside. Each order when received
will be immediately distributed to the next market maker. Thus,
order one at second one is distributed immediately to market maker
one, while order two at second two is sent to market maker two
immediately, and so on through order five. In most circumstances,
each market maker will not decline the order within 20 seconds, and
thus, each order would be executed within 20 seconds of processing.
If any one of these orders were declined, the order would wait for
the next available market maker for re-presentation. If that market
maker remained at the same price level as that when the order was
originally presented, the order would be subject to a further 20-
second reaction period. In the unlikely event it was declined again,
the order would be presented again for execution. If that
presentation occurred at a new price level, it would be immediately
executed at the new price level.
If order entry firms enter more orders than there are market
makers at the inside, the queue for such orders would be the same as
today in SOES when orders must be queued while waiting for a market
maker to update its quotation after a SOES execution. Consequently,
the NASD believes that queuing under this proposal does not
represent a significant threat to prompt market order execution much
different from current queuing. It should be noted as well, that
market orders of eligible size entered into NAqcess are guaranteed
an execution. Such execution may be effected against a customer
order or a dealer's quote. Thus, in response to concerns raised in
some comment letters the NASD received in response to Notice to
Members 95-20 and 95-60, NAqcess will provide guaranteed executions
to investors entering eligible market orders. Accordingly, the NASD
believes that those comment letters from individual investors that
allege that NAqcess will deprive them of an automatic execution are
mistaken. Of course, it should be noted that not even in SOES is a
market order guaranteed an execution at the price observed at the
time the order was entered. Similarly, under NAqcess no such
guarantee is extended to an investor.
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NAqcess and its companion rules represent a significant enhancement
to the treatment of investor orders in The Nasdaq Stock Market. The
entire proposal, when taken together with other recent enhancements to
the Nasdaq trading environment, such as the Limit Order Protection
Interpretation 5 and the Short Sale Rule,6 demonstrates the
significant strides that the NASD and The Nasdaq Stock Market have
taken to provide increased protection of investors while continuing to
preserve the benefits that its competitive dealer market structure
currently provides. Individual investors seeking price improvement over
the dealer quotation will be afforded a transparent mechanism to obtain
greater opportunities for price improvement over the dealer quotation
without market maker interaction. Moreover, through the accompanying
rules, NAqcess will provide such limit orders with increased market-
wide price protection. Individual investors seeking rapid execution of
small market orders at the best available price will continue to be
able to obtain executions promptly, while Nasdaq market makers will be
permitted the opportunity to interact with such orders in a manner
consistent with SEC rules and in a manner similar to market order
handling in exchange markets. By permitting market makers to continue
the operation of their own internal execution systems, the NASD will
maintain the ability of dealers to provide liquidity and competitive
mechanisms to handle customer orders.
\5\ Securities Exchange Act Release Nos. 35751 (May 22, 1995),
60 FR 27997 (May 26, 1995) and 34279 (June 29, 1994), 59 FR 34883
(July 7, 1994).
\6\ Securities Exchange Act Release No. 34277 (June 29, 1994),
59 FR 34885 (July 7, 1994).
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2. NAqcess Operations
The proposed NAqcess system will provide the following:
A. Scope of System. NAqcess will be available for all Nasdaq
issues. It will completely replace SOES which will operate until the
effective date for operation of NAqcess and will be discontinued as of
that date. NAqcess participation will be mandatory for market makers in
all National Market securities. NAqcess participation for SmallCap
market makers will be voluntary, as is SOES participation today for
such market makers.
B. Order Entry Requirements. Agency orders may be entered into
NAqcess only by member firms on behalf of customers. ``Customers'' are
defined to
[[Page 63094]]
exclude any broker, dealer, person associated with a member, or a
member of the immediate family of a person associated with a member.
Because the purpose of the system is to provide small retail customers
with access to The Nasdaq Stock Market, member firms, with one limited
exception,7 are not permitted to enter proprietary orders.8
As explained in more detail elow, customers may request that
appropriately sized limit and market orders be entered into NAqcess,
and if so requested, member firms must honor the customer's
request.9
\7\ The only exception to the proprietary order prohibition is
an order designated by a market maker as a ``marker order.'' A
marker order is a principal order entered by a market maker in a
transaction that is functionally the equivalent of a riskless
principal transaction. The firm may place a principal account limit
order in the NAqcess file, and if an execution is obtained,
immediately pass along the benefit of such execution to a retail
customer order it holds in its own file. Because the order is part
of a principal transaction for the benefit of the retail customer,
the NASD believes that it is appropriate to permit this limited
exception to the prohibition of proprietary orders in NAqcess. The
NASD will require member firms entering such orders to mark their
order tickets accordingly, and will examine a firm's trading
activities carefully to determine that such proprietary orders are
being effected for the purposes of engaging in a riskless principal-
like transaction. Marker orders, however, may not be placed with
respect to customer limit orders held by the firm that exceed the
permitted maximum limit order size.
\8\ Member firms will be permitted, however, to enter so-called
``takeout'' orders for their own account or on behalf of a customer.
A takeout order is an order that results in an immediate automatic
execution of a limit order or orders in the NAqcess limit order file
at the limit order price(s). There is no size limitation on the
takeout order. Thus, if the NAqcess file displays limit orders at a
price with an aggregate size of 15,000 shares, a single takeout
order of 15,000 shares may be entered and executed. Similarly, a
firm may enter a takeout order to immediately execute multiple limit
orders at multiple prices in the NAqcess file. When there are
multiple limit orders being taken out, each limit order will execute
at each limit order's price.
\9\ See infra Section II(A)3.A of this proposal.
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Customers may request the entry of limit orders up to 1,000 shares
in National Market and SmallCap issues, except for the Nasdaq 100
issues, in which case limit orders up to 3,000 shares may be entered.
This represents a difference from the original proposal 10 of
3,000 shares for all National Market issues.11 The issue of size
eligibility for limit orders generated significant comment in response
to the two Notices.12 Many commenters believed that because
NAqcess is intended to provide small retail customers with limit order
protection, the initial approach should reflect more closely that the
average retail order size is well under 1,000 shares. For example, the
Security Traders Association (``STA'') noted that the experience of STA
members was that the typical retail customer order size averaged well-
less than 1,000.13 It was also noted by commenters that it could
reduce the potential for investor confusion if NAqcess established a
standard for limit orders that was consistent with market order size,
1,000 shares. Commenters also noted that NAqcess could potentially
significantly impact market maker participation, particularly in less
active securities. As a result, they suggested that the NAqcess order
size should be set at lower levels at least until the NASD had
thoroughly evaluated the impact of the system on market liquidity.
\10\ NASD Special Notice to Members 95-20 (Mar. 21, 1995).
\11\ All SmallCap issues have a limit order size of 1,000
shares.
\12\ NASD Special Notice to Members 95-20 (Mar. 21, 1995) and
95-60 (July 27, 1995).
\13\ See letter from John Giesea, Chairman, and John Watson,
President, STA (Apr. 28, 1995).
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While the NASD believes that NAqcess will have overall a positive
effect on market quality, we believe that it is prudent in this start-
up period to commence NAqcess limit order size eligibility at 1,000
shares for most securities. However, limit orders up to 3,000 shares
would be eligible for NAqcess for those securities that comprise the
Nasdaq 100 Index. The NASD believes that this higher eligibility level
is appropriate because the securities comprising the Nasdaq 100 have
high levels of volume, greater market maker participation and
significant market liquidity and therefore are less likely to be
adversely impacted by the proposal. Because of the significant changes
that NAqcess may bring to The Nasdaq Stock Market, the NASD believes
that it is appropriate to commence the operation of the system with a
smaller limit order size than originally proposed to permit market
makers and investors to adjust to the new trading environment. The NASD
proposes to monitor the limit order size requirement carefully in the
initial eighteen months of NAqcess operation and may choose to expand
the eligible size of limit orders, if experience demonstrates such
expansion to have merit.
Market orders in National Market issues may be 1,000, 500 or 200
shares depending upon tier size determination to be made in the same
manner as done in SOES today.14 Similarly, market orders in
SmallCap issues will be tiered at 500 shares or less as done in SOES
today.15
\14\ Under SOES Rules, the tier sizes of 1,000, 500 and 200
shares were determined by reference to the average daily non-block
volume of a security, among other things. Thus, for example, if an
issue had an average daily non-block volume of 3,000 or more shares,
it could qualify for a tier size of 1,000 shares.
The same concept will apply with respect to NAqcess maximum
market order sizes, except that the NASD has determined to use a
slightly higher average daily non-block volume of 6,000 shares. The
NASD has chosen this higher level because it better reflects trading
patterns consistent with the increased overall volume in Nasdaq
securities.
\15\ The NASD will permit market makers to establish minimum
exposure limits that are equal to the maximum market order size. In
addition, NAqcess will contain an automated update feature that will
automatically change the market maker's quotation by a minimum
increment set by the market maker after the market maker has
executed a trade at a price level and has exhausted its minimum
exposure limit through system executions. The NASD believes that
these aspects of NAqcess are critical to an effective operation that
permits a market maker to manage its risk capital, and is consistent
with the SEC firm quote rule as applied to all other registered
markets. The minimum exposure limit is set at the same size as the
minimum quote size in Nasdaq. Under the SEC Firm Quote Rule (Rule
11Ac1-1(c)), a broker-dealer is entitled to change its quotation
within a reasonable period of time after it has completed a trade at
its published price. Accordingly, the NASD believes that these
aspects of NAqcess are consistent with SEC and NASD rules and
provide retail investors with the same access to dealer quotations
as are available in any other registered marketplace.
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Customers may choose to enter ``marketable limit orders.'' A
marketable limit order is a limit order that is priced at the time of
entry at the current inside market or better on the opposite side of
the market, i.e., a marketable limit order to buy is equal to or higher
than the current inside offer, while a marketable limit order to sell
is equal to or lower than the inside bid. For example, if the current
inside market is 20 bid and 20\1/4\ asked, the entry of limit orders to
sell priced at 20 or 19\7/8\ would be considered marketable limit
orders. Marketable limit orders will be treated as market orders. Thus,
if a firm enters a customer limit order to sell at 20 at the time the
inside bid is 20, the limit order will be passed over the limit order
file and if no match occurs, it will be treated as a market order and
executed as discussed above in the market order handling section. If
such marketable limit order, however, is greater than 1,000 shares in a
Nasdaq 100 security, the marketable limit order will be returned to the
order entry firm for handling outside of NAqcess, without matching
against the inside market whether the inside consists of a dealer
quote, limit order(s), or an aggregation thereof.
Neither a limit order nor a market order may be split up to meet
the size parameters of NAqcess. The NASD will examine order handling
practices of
[[Page 63095]]
order entry firms to determine compliance with this requirement.16
\16\ In this regard, the NASD notes that order entry firms may
enter agency orders only. The rules continue in effect the
definition of agency orders as found in the current SOES Rules and
the new rules carry forward the existing principles regarding the
aggregation of orders based on a single investment decision entered
by an order entry firm. Orders entered by an order entry firm within
any five minute period in accounts controlled by associated person
or public customers, acting alone or in concert with other
associated persons or public customers are presumed to be based on a
single investment decision. In connection with this rule, the NASD
notes that it will examine carefully the entry of computer-generated
orders to determine whether such orders are based upon a single
investment decision.
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C. Display of Limit Orders. To enhance the transparency of The
Nasdaq Stock Market and to assist in the price discovery process, the
NASD will provide for the display of limit orders entered into NAqcess.
There will be two separate approaches to the display: a consolidated
inside market display and the Full File Display.
1. Inside Market Display. In a significant revision to Nasdaq's
methodology for calculating the inside market for Nasdaq securities,
The Nasdaq Stock Market will include in the Nasdaq inside market
NAqcess limit orders, and their aggregate sizes, that are priced the
same as or better than the best dealer bid and offer.17 Thus, in
Nasdaq the inside market will consist of a single display of the best
priced quotes or limit orders, as the case may be. The inside market
will be calculated in the following manner. If the best limit order(s)
to buy (sell) in NAqcess is (are) better than the best Nasdaq market
maker bid (offer) displayed in Nasdaq and such limit order(s) is (are)
100 shares or more, it (they) will be included in the Nasdaq inside
market and disseminated as the inside bid (offer), together with the
aggregate size of such order(s) and a unique indicator to denote that
the inside market is represented by a NAqcess limit order or orders,
rather than a quotation of a Nasdaq market maker or UTP exchange
quotation. If there are multiple limit orders at the best price,
aggregate size will be displayed and execution of such orders will
occur on a time priority basis as explained below.
\17\ This is a change from the approach originally proposed in
Special Notice To Members 95-20 and 95-60. In the original NAqcess
approach to the display of NAqcess limit orders, the NASD proposed
to provide two separate displays of prices: the inside dealer
quotation (i.e., the best-priced bids and offers of Nasdaq market
makers and UTP exchanges displayed in the Nasdaq market) and the top
of the NAqcess limit order file (i.e., the best-priced limit orders
to buy and sell and their aggregate sizes). Such displays would have
been separate and side-by-side. Under this new proposal, the NASD
will maintain a Top of the File display on its Nasdaq Workstations,
as well as include the best priced limit orders to buy and sell in
the Nasdaq inside market display.
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If the best-priced NAqcess limit order(s) is (are) equal to the
inside dealer quotation, the limit order size will be reflected in the
aggregate size of the quotation. That is, if there is a limit order to
buy 500 shares at the same price as a 1,000 share dealer bid quotation,
and both are the best bids reflected in Nasdaq, the aggregated size
displayed as the best Nasdaq bid will reflect a size of 1,500 shares
with a special indicator to denote that such size is an aggregation of
a dealer quote and any limit order(s) at that price. Priority for
execution will depend upon the general limit order priority rules,
i.e., if the limit order is received prior to the market maker
quotation, it will be entitled to priority for execution
purposes.18
\18\ Rules regarding calculation of the excess spread will not
include NAqcess limit orders for purposes of determining compliance
with those Rules. See NASD Manual, Schedules to the By-Laws,
Schedule D, Part V, Sec. 2(d), CCH para. 1819.
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The inclusion of NAqcess limit orders in the Nasdaq inside market
represents a significant enhancement to The Nasdaq Stock Market.
Consolidation of NAqcess orders into the Nasdaq inside quotation is the
best means to communicate clearly to all investors in Nasdaq the true
market for such securities at any particular point in time. The
consolidation of best-priced limit orders with the best dealer bid and
offer in Nasdaq provides the best level of transparency and aids in the
price discovery process.
Although this represents a change from the original NAqcess
proposal,19 the NASD believes that the display of this
consolidated information maintains the advantages of a competing dealer
market while permitting an expansion in information available to
investors.20 The new inside quotation display will clearly
identify when aggregated customer limit orders are represented in the
inside market display. Accordingly, market participants will be able to
ascertain when the inside quotation represents a customer limit order
and when it represents a market maker whose quotation may signify that
it is available to effect a significantly larger sized transaction. In
this way, the NASD believes that transparency of customer orders may be
enhanced while the integrity of the dealer quotation is preserved.
\19\ NASD Special Notice to Members 95-60 (July 27, 1995).
\20\ One commenter specifically noted that a consolidated
display of the best priced limit orders in the Nasdaq inside market
was a better approach than maintaining separate displays, especially
since member best execution obligations would be determined by
reference to the best prices displayed by Nasdaq, whether such
prices were dealer quotes or limit orders in NAqcess. See Lehman
Bros. (Sept. 12, 1995). In addition, several vendors expressed
technological concerns regarding separate displays. See letters from
ADP (Aug. 16, 1995) and Telekurs (Aug. 14, 1995).
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2. Full File Display. The full file display for a particular
security will be made available on a query basis over Nasdaq
Workstations only to Nasdaq market makers in that security. The NASD
believes that, as with other U.S. market centers, display of the entire
limit order file should be reserved to market makers in a particular
security to assist in price discovery and to provide the market maker
with an incentive to provide liquidity by risking its capital. In fact,
no U.S. exchange registered with the SEC publicly disseminates any
display (full or partial) of a limit order book maintained by an
exchange specialist. Because of the accompanying rules described below
that the NASD has proposed, customer limit orders in the file will be
protected to a large extent, from inferior executions.
D. Order Processing. The NAqcess system will provide significant
improvements over the current SOES system in the way that customer
limit orders and market orders will be handled. NAqcess will attempt to
match all incoming orders, limit or market, directed or non-directed,
against limit orders already resident in NAqcess on a price and time
priority basis.21 If a match is found, the orders will be
automatically executed against each other without the participation of
a market maker. For example, assume the current inside market for a
security is 20-20\1/2\ and customers enter into NAqcess a 1,000 share
limit order to buy at 20\1/8\ and a 1,000 share limit order to sell at
20\3/8\. The new inside market will become 20\1/8\-20\3/8\. If a
customer thereafter enters a 1,000 share limit order to sell at 20\1/
8\, the incoming limit order to sell will match against the 1,000 share
limit order to buy on the NAqcess file at 20\1/8\ and will be executed
against that order. If a
[[Page 63096]]
customer next sends in a market order to buy in NAqcess, the market
order will match against the limit order to sell at 20\3/8\, rather
than the dealer offer of 20\1/2\, and thus, the market order will be
automatically executed immediately at 20\3/8\. In both cases, the
orders received price improvement over the dealer quotation and
immediate execution without the participation of a market maker.
\21\ NAqcess will match only round lots and round lot portions
of mixed lot orders. Odd lot limit orders will not be matched. Odd
lots are orders less than 100 shares. Odd lot limit orders will not
be displayed in the inside quotation; however, odd lot limit orders
will be displayed in the full file display. If an odd-lot order is
executable i.e., if it is a market order or an executable limit
order, it will be automatically executed at the applicable inside
dealer quotation. If it is a directed order, it is executed against
the directed market maker. If it is a non-directed order, it will be
executed automatically without any decline capability against the
next available market maker at the inside dealer quotation. If the
odd-lot order is a limit order that is not executable at time of
entry, it will remain in the file until the inside dealer quotation
moves to match the odd-lot price.
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If, in the scenario set forth above, the second limit order to sell
is priced at 20 instead of 20\1/8\, the execution price would be 20\1/
8\, the price of the limit order to buy because such order was entered
into the system earlier than the second limit order to sell.
The system will only execute such matches when the execution prices
would be equal to or better than the inside market. Nevertheless, limit
orders priced away from the inside market, i.e., limit orders to sell
priced higher than the inside offer and limit orders to buy priced
lower than the inside bid, will be stored in the NAqcess file. When the
inside market moves to a price so that the limit order is equal to or
better than the inside dealer quotation, such limit orders will be
consolidated into the Nasdaq inside market and the limit order will
become eligible for matching as described in this section.
When a limit order in the NAqcess file is priced the same as the
inside market, the time priority of the limit order compared with the
best dealer quotation will govern which price interacts first with
incoming orders in NAqcess. The NASD believes that this approach is a
well-understood and reasonable means for determining the interaction of
such orders and provides a further incentive to market makers to
provide liquidity and narrow spreads.
If no limit orders reside in the NAqcess file, market orders will
be immediately assigned and distributed to market makers at the inside
market. This rapid distribution should minimize the potential for
queues that the original proposal found in Notice To Members 95-20
could have caused. After an order is distributed to a market maker, the
market maker will be permitted a 20-second period within which it may
decline a non-directed order if such action is consistent with the
exceptions to the SEC's firm quote rule, Rule 11Ac1-1.22 In other
words, the market maker is permitted to decline the NAqcess order if
the market maker, immediately before the presentation of the NAqcess
order: (a) effected or was in the process of effecting a trade, and (b)
was in the process of updating its quotation to reflect that previous
transaction. When a NAqcess order is declined by a market maker, the
declined order is presented to the next available market maker. If that
market maker is at the same price as the market maker that originally
declined the order, the second market maker also has a 20-second period
to react to the order. If the second time the order would be presented,
the inside market has moved to a different price level, it is
automatically executed without any decline capability. For example,
four market makers are at the inside bid of 20. Three market orders to
sell are entered into NAqcess when there are no limit orders to buy at
20 or better. Each market order is immediately distributed to one of
the three market makers. Because the first market maker had completed a
trade by telephone and was about to change its quotation, the first
market order is declined by the first market maker. That order is
redistributed to the fourth market maker still quoting a price of 20.
The fourth market maker has 20 seconds to interact with the order. If,
however, there were only three market makers at 20, and all market
makers had updated their quotations to reflect a price of 19\7/8\, the
declined order would be immediately executed at 19\7/8\ against the
first available market maker without any decline capability.
\22\ While the total time period between order entry and Nasdaq
receipt of the decline is 20 seconds, the system has been designed
to provide market makers with a full 15-second period in which to
react to an order. The rule itself references a 15-second period in
which the market maker must react. Five seconds of the 20-second
period is designed to accommodate communications between Nasdaq
systems and the market maker. Thus, the NASD has purposefully
designed a 5-second period to accommodate the transmission of
messages between the NASD host computer and member firm presentation
devices. This five-second period addresses the potential delays of
3.75 seconds that may occur in broadcasting a message from the host
to a workstation, and the .775 seconds that could occur in
transmitting a decline message from the presentation device to the
host. (It should be noted that such time periods arise in the
context of the current configuration of the proposed system.
Development of alternative methods of processing could increase the
total time delays.) In examining the potential length of time that a
message could consume in transmission from the host to the
presentation device and back again, the NASD determined that market
makers would be at a significant time disadvantage in that a market
maker could lose up to 33% of its already limited reaction period.
In this context, then, the NASD believes that it is appropriate to
recognize the inherent delays of computer-to-computer data exchange,
and provide additional time to account for such delays.
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The NASD is developing an automated surveillance capability to
monitor on a real-time basis whether an order was properly declined.
The NASD believes that this capability is crucial to engendering
investor confidence in the firmness of Nasdaq market maker quotations
and should alleviate any concerns regarding ``backing away'' questions.
The NASD notes that the 15-second decline feature was criticized in the
context of the NProve proposal.23 The NASD believes that
this proposal to develop a real-time automated surveillance capability
should alleviate any concerns about the ``decline'' capability. The
NASD will undertake strong disciplinary measures against any firm that
displays a pattern and practice of improper order declines.
\23\ See Securities Exchange Act Release No. 35275 (Jan. 25,
1995), 60 FR 6327 (Feb. 1, 1995).
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Order entry firms have two alternatives in entering NAqcess
orders--they may direct the order to a particular market maker with
whom they have established a direct order arrangement, or they may
enter a non-directed order. In either circumstance, market orders and
marketable limit orders will first pass over the limit order file to
obtain a match before execution against a market maker. If an order is
directed pursuant to a valid agreement between the order entry firm and
the market maker, the market maker may not decline the order.
E. Opening Procedures. NAqcess will have special opening procedures
that are consistent with the opportunities for order matching and price
improvement over the dealer quotation provided intra-day by NAqcess.
NAqcess's operating hours are from 9:30 a.m. to 4:00 p.m. (EST).
However, limit orders may be entered and stored in NAqcess from 4:00
p.m. to 6:00 p.m. and limit and market orders may be entered from 8:30
a.m. to 9:28 a.m. At 9:28 a.m., no further orders for opening purposes
will be accepted.24 At 9:30 a.m., Nasdaq will rank all limit
orders stored as of 9:28 a.m. according to price and time of entry. To
the extent orders are available, the system will then match the best-
priced sell limit orders against the best-priced buy limit orders in
the file that are within the best dealer bid and offer as determined at
9:30 a.m. When all available limit order matches are effected, any
remaining limit orders within the inside dealer quote at 9:30 a.m. will
be matched against market orders stored as of 9:28 a.m. and will be
executed at such limit order prices. Any remaining orders will be
subject to the normal intra-day, order distribution and execution
procedures. It should be noted that this opening procedure will not
create a single, unitary price for all orders in NAqcess. The
individual
[[Page 63097]]
prices of each match will be reported. Thus, assuming the dealer
quotation is 20-20\1/2\, if the file contains two limit orders to buy
at 20\1/8\, each for 1,000 shares, and there are also three 1,000 share
limit orders to sell at 20\1/8\, two 1,000 share limit orders to sell
at 20\1/4\, and 4,000 shares to buy at the market, the system will
execute as follows: the first two in time priority of the three 1,000
shares sell limit orders at 20\1/8\ will be matched against the two
20\1/8\ 1,000 share buy limit orders. The first 3,000 shares to buy at
the market will be matched against the remaining limit orders to sell,
with the first market order in time receiving an execution of 20\1/8\
and two 1,000 share market orders next in time receiving executions of
20\1/4\. The remaining 1,000 share market order will be executed
against the dealer quote according to the normal post-opening execution
algorithm.
\24\ Orders entered from 9:28 a.m. to 9:30 a.m. will be stored
and handled after the opening in line with ordinary matching and
handling procedures described above.
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3. Rules of Fair Practice
The NASD is also proposing in conjunction with NAqcess three major
changes to the Rules of Fair Practice. Under the proposed new rule and
Interpretations, the treatment of limit orders will be significantly
changed to promote price protection of such orders throughout The
Nasdaq Stock Market. These proposed rule changes provide greatly
enhanced limit order treatment over current practices. Together with
existing limit order protections already in place (i.e., the so-called
``Manning'' rule), the new proposals provide investors placing limit
orders with significantly enhanced protections against limit order
trade-throughs throughout The Nasdaq Stock Market.
A. Customer Order Handling. The NASD is proposing a new
Interpretation under Article III, Section 1 of the Rules of Fair
Practice. Under the proposal, if a customer requests that his or her
order be entered into NAqcess, the member firm must do so. While the
Interpretation permits a firm to charge for such services and to
recommend the use of its own execution system, the member is not
permitted to discriminate against customers that choose NAqcess over an
internal system by imposing unfair commissions or charges. The proposed
Interpretation covers both market and limit orders.
B. Price Protection. The NASD is also proposing a new rule in the
Rules of Fair Practice that would prohibit a member firm, whether
acting as a principal or as an agent, from executing any order at a
price inferior to any limit orders that the firm is able to see in the
NAqcess limit order file.25 An inferior price means an execution
price that is lower than a buy limit order or higher than a sell limit
order that a member firm is able to see in the NAqcess limit order
file. This prohibition means that limit orders in the NAqcess file will
not be traded through elsewhere in Nasdaq in most circumstances. A
member firm's activity with respect to protecting NAqcess limit orders
must be consistent with its best execution obligations to its own
customers. When a firm acts as principal in filling a NAqcess limit
order when it is in possession of an executable customer market order
on the other side of the market, it should pass on the benefit of the
NAqcess trade to the customer order. If the firm in receipt of the
market order is acting as agent for its own customer's order, its best
execution obligation would mean that it should select the appropriate
market for execution, which could be NAqcess.
\25\ It should be noted that placement of a customer limit order
in the NAqcess file does not relieve a member firm of its obligation
under the Limit Order Protection Interpretation of Article III,
Section 1 of the Rules of Fair Practice that prohibits a member firm
from trading ahead of a customer limit order it has been entrusted
with. Under the so-called ``Manning'' Interpretation, if a member
firm holding a customer limit order, whether from its own customer
or as a result of a member-to-member order, places that order into
NAqcess, the member firm is nevertheless prohibited from trading at
the same price or at an inferior price to the customer order. Thus,
while the newly proposed price protection rules speak in terms of
protecting NAqcess orders from inferior priced transactions, if the
NAqcess order is the firm's customer's order or a member-to-member
order it placed in NAqcess, the firm may not trade at the same price
without protecting that order.
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The price protection obligation is related to the ability of the
firm to view the orders in the limit order file. Thus, under the
proposal's current configuration, limit orders at the top of the file
and included in the inside market calculation must be protected by all
member firms. Under NAqcess system rules, limit orders ranked below the
top of the file are viewable only by market makers in the particular
security. Accordingly, market makers in a particular security would be
obligated to protect all limit orders in that security in the NAqcess
file from inferior executions that they may engage in.26 Thus, if
a market maker in a security sought to execute a 1,000 share trade at
20, when the NAqcess file displayed limit orders to buy at 20\1/8\ and
20\1/4\, the market maker would be required to either execute the limit
orders first or contemporaneously, depending on the size of the limit
orders in NAqcess.27
\26\ In today's environment, market makers are involved in
approximately 83% of all Nasdaq trades. Consequently, it is likely
that in a large majority of trades when NAqcess is operational, a
market maker will be involved, and thus, orders away from the top of
the file typically will be protected as well as the top of the file.
\27\ The NASD will interpret the price protection rule to not
apply to member firms that operate passively-priced crossing
systems, such as POSIT and Instinet's Crossing Network. Generally
speaking, such systems execute prices at the dealer quotation spread
midpoint and would not likely trade through a NAqcess order. Members
that believe that they operate systems that could qualify for this
exemption should submit a request for exemption to the NASD.
The proposed rule would apply, however, to ordinary broker-
dealer trading systems such as Instinet's regular trading session.
Because many such trades could occur at prices that could be
inferior to limit orders in NAqcess, the NASD believes it
appropriate that such NASD member firms should protect NAqcess
customer limit orders as would any other registered broker-dealer
member firm. Orders placed in SelectNet that trade through NAqcess
are also subject to the price protection rule.
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The NASD believes it important to explain for the purposes of the
price protection rule and the Interpretation regarding equivalent price
protection for limit orders held outside of NAqcess, that the
protectible price that generates a firm's obligation to provide price
protection is the price reported for last sale reporting purposes. Some
confusion has occurred regarding limit orders trading at an ``inferior
price,'' especially in the context of internal sales credits. If the
execution price reported via ACT for Schedule D transaction reporting
purposes includes an internal sales credit that will be provided to a
sales representative at the firm, the price that triggers the member
firm's obligation to protect a limit order is the reported price. The
internal sales credit included in the reported price has no effect on
the obligation to protect the NAqcess limit order.28
\28\ See NASD Special Notices To Members 95-43 (July 27, 1995)
and 95-67 (Mar. 21, 1995) for a more detailed discussion of the
proper means for protecting customer limit orders when firms are
dealing at net prices. The same concepts apply in the context of
protecting system limit orders.
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C. Equivalent Price Protection. As noted earlier, the NASD, to
encourage competition and to enhance the liquidity of The Nasdaq Stock
Market, has determined that market makers should continue to be
permitted to operate their own internal execution systems and to handle
limit orders outside of NAqcess. However, the NASD also believes it is
important to provide limit orders held outside of NAqcess with price
protection substantially equivalent to that which NAqcess orders would
have. Accordingly, the NASD has proposed an Interpretation to Article
III, Section 1 of the Rules of Fair Practice
[[Page 63098]]
that provides substance to the term equivalent price protection.29
\29\ The equivalent price protection Interpretation would not
apply to continuous trading systems, such as that operated by
Instinet, because such customers are generally sophisticated and
have deliberately opted to trade in an alternative trading system.
Such customers are institutions and broker-dealers that seek other
advantages in trading in these alternative systems. Because of their
sophistication, these customers believe they do not need the broker-
dealer operating the system to provide equivalent price protection.
Accordingly, the NASD will provide an exemption from the
Interpretation to brokers operating such systems if they seek an
exemption.
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First, a member firm holding a protectible customer limit order
30 outside of NAqcess must provide such order with print
protection, if any transaction at a price inferior to the customer
limit order occurs.31 Thus, any firm holding a protectible
customer limit order is required to contemporaneously execute, up to
the size of the reported transaction, the customer limit order at the
limit order price if an inferior-priced execution is reported in that
security. ``Contemporaneously'' means within approximately 60 seconds
of the trade report. For example, firms A and B each hold 1,000 share
customer limit orders to buy priced at 20\1/8\. A 1,000 share trade is
reported at 20. Both firms A and B are obligated to execute their limit
orders at 20\1/8\ within 60 seconds of the trade report. If the
triggering trade report had been 500 shares at 20, each firm owed its
customers executions of at least 500 shares at 20\1/8\.
\30\ A ``protectible'' order is a customer order of a size that
would be eligible for entry into NAqcess. Accordingly, the
Interpretation requirements do not extend to customer limit orders
that are larger than 1,000 shares (or larger than 3,000 shares for
Nasdaq 100 securities).
\31\ A member's obligation to provide print protection will not
be triggered by a trade report that has a special modifier, such as
.SLD or otherwise, appended to it. Because such modifiers indicate
the trade being reported is out of sequence or was executed under
special conditions, such trade reports should not require an
execution of a limit order. The NASD will closely monitor member's
usage of special trade reporting modifiers to ensure that firms to
not use such modifiers as a vehicle to avoid print protection
obligations under the new rule.
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Next, if the firm holds a protectible customer limit order at a
price that would match a limit order in the NAqcess file, the firm must
either execute its limit order or send its limit order to NAqcess for
matching. ``Matching'' means that the NAqcess limit order is the same
price or lower than the firm's customer's limit order to buy or higher
than the limit order to sell.
The same matching would be required if the firm holds offsetting
limit orders within its own file. If the firm holds a limit order to
sell at 20\1/4\ and accepts a limit order to buy at 20\1/4\ or higher,
the firm must execute the two orders against each other. Finally, if
the firm holds a limit order that is priced equal to or better than the
inside market in Nasdaq, and if the firm accepts a customer market
order for automated execution at the inside market, the firm must first
match the market order against the limit order before it can execute
the market order for its own account.
4. NAqcess Proposal--Consistent With Securities Exchange Act
The proposed NAqcess system and the accompanying proposed rule
changes in the Rules of Fair Practice propose significant structural
changes in The Nasdaq Stock Market that greatly benefit investors in
their handling of limit orders, price improvement over the dealer
quotation, and rapid execution of orders. It is important to note that
no previous proposal for a Nasdaq order handling and execution system
has been so interrelated with such significant changes to rules that
provide price protection across the Nasdaq market. The two
developments--a new system with advanced order matching features and
greater transparency along with the dramatic changes to price
protection of orders in and outside the system--must be considered as a
part of a fully integrated approach to the handling of retail customer
orders. Together, they permit retail investors greater opportunity to
participate directly in the market through the use of limit orders and
substantially increase their ability to receive executions between the
best dealer bid and offer. Further, the NASD believes that the approach
to changes in The Nasdaq Stock Market proposed in this rule filing
helps to guarantee investor protection and fairness to all market
participants, while still allowing the market makers to operate in a
competitive dealer market. The enhanced price discovery features, the
transparency of limit orders, and the interaction of limit orders and
market orders should add to the liquidity, efficiency and immediacy of
Nasdaq's competing dealer market structure.
Accordingly, the NASD believes that the proposed rule change is
consistent with Sections 15A(b)(6), 15A(b)(9), 15A(b)(11) and
11A(a)(1)(C) of the Act. Section 15A(b)(6) requires that the rules of a
national securities association be designed to prevent fraudulent and
manipulative acts and practices, to promote just and equitable
principles of trade, to foster cooperation and coordination with
persons engaged in regulating, clearing, settling, processing
information with respect to, and facilitating transactions in
securities, to remove impediments to and perfect the mechanism of a
free and open market and a national market system and in general to
protect investors and the public interest. Section 15A(b)(9) requires
that rules of an Association not impose any burden on competition not
necessary or appropriate in furtherance of the purposes of the Act.
Section 15A(b)(11) requires the NASD to formulate rules governing the
quality of fair and informative quotations. Section 11A(a)(1)(C) finds
that it is in the public interest to, among other things, assure
economically efficient execution of securities transactions. The
fundamental purpose of NAqcess is to assist investors in achieving
prompt, efficient executions of their small orders and to provide an
opportunity for price improvement over the dealer quotation within an
automated execution environment. The integrity and efficiency of Nasdaq
for public investors and market-making participants is critical and the
NASD believes that NAqcess will provide benefits to both
constituencies. The design of NAqcess is not anti-competitive as it
treats all non-directed orders uniformly; to the extent that directed
orders are distinguished, by entering into such arrangements with known
customers, market makers effectively waive the protections offered by
the system.
The new proposals are also fully consistent with the significant
national market system objectives contained in Section 11A of the Act.
The NAqcess national limit order facility would advance these
objectives by offering efficient execution of investors' small orders,
by maintaining market maker participation through the automated
delivery of orders with the ability to reject those orders if trades
have already occurred, and by offering the opportunity for price
improvement over the dealer quotation to orders both inside and outside
of the NAqcess system. The system's functionality will more accurately
reflect market makers' affirmative obligations to provide liquidity to
the market, without depriving market makers of legitimate exceptions
from the firmness requirements contained in Rule 11Ac1-1. In sum, the
NASD believes that the entire proposal set forth herein significantly
advances the goals of investor protection and greater access to The
Nasdaq Stock Market.
(B) Self-Regulatory Organization's Statement on Burden on Competition
The NASD does not believe that the proposed rule change will result
in any
[[Page 63099]]
burden on competition that is not necessary or appropriate in
furtherance of the purposes of the Act, as amended.
(C) Self-Regulatory Organization's Statement on Comments on the
Proposed Rule Change Received from Members, Participants, or Others
Written comments are discussed above.
III. Date of Effectiveness of the Proposed Rule Change and Timing for
Commission Action
Within 35 days of the date of publication of this notice in the
Federal Register or within such longer period (i) as the Commission may
designate up to 90 days of such date if it finds such longer period to
be appropriate and publishes its reasons for so finding or (ii) as to
which the self-regulatory organization consents, the Commission will:
A. By order approve such proposed rule change, or
B. Institute proceedings to determine whether the proposed rule
change should be disapproved.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views, and
arguments concerning the foregoing. In particular, the Commission
requests general comments concerning the NASD's proposal and whether it
is consistent with the Act. In addition, the Commission invites
interested persons to address the following specific issues:
(1) The Commission recently proposed rules concerning order
execution obligations.32 Among other things, the Commission's
proposal generally would: (a) require Nasdaq market makers to display
in their quotations (1) customer limit orders priced better than the
market maker's current quotation, or (2) the size of a customer limit
order that equals the current inside bid or offer; and (b) require that
market makers offer market orders for certain securities an opportunity
for price improvement over the current national best bid or offer. The
Commission seeks comment on whether the NASD's proposal is consistent
with the Commission's proposal and with the goals set forth in the
Commission's release;
\32\ Securities Exchange Act Release No. 36310 (Sept. 29, 1995),
60 FR 52791 (Oct. 10, 1995).
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(2) The NASD's proposal would eliminate SOES and does not include
the immediate automatic execution feature for market orders currently
available in SOES. In light of historical concern about the
accessibility of market maker quotations,33 the Commission seeks
comment on the possible effects this change could have on the Nasdaq
market and retail investors;
\33\ Division of Market Regulation, SEC, The October 1987 Market
Break 9-19 (1988).
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(3) The SOES Rules provide a market maker a five-minute period
within which to update its quotation or reestablish its exposure limit
after its exposure limit has been exhausted. Further, the current
operation of SOES allows for a market maker to elect to use an
automated quotation update feature which, generally, changes, by a
prespecified increment, the market maker's quotation after its SOES
exposure limit is exhausted. The NASD's NAqcess proposal would continue
both of these features. In light of the automated quotation update
feature and the lack of immediate automatic execution that would occur
under NAqcess, the Commission seeks comment on whether there is a
continuing need for the five-minute grace period;
(4) The NASD proposes to modify the methodology for calculating the
inside Nasdaq market to include both dealer quotations and NAqcess
limit orders. If a NAqcess limit order equals or improves the best
market maker quotation, it will be included in the Nasdaq inside market
and disseminated as the inside quotation, including the aggregate size
of all orders at that price. Further, the NASD proposes to use a unique
indicator to denote when the inside market is represented by a NAqcess
limit order, rather than a dealer or UTP exchange quotation. The
Commission requests comment on whether using an indicator for a NAqcess
limit order is appropriate;
(5) As discussed above in the NASD's proposal, priority of NAqcess
executions when the best bid or offer consists of both a market maker
quotation and a NAqcess limit order would be based on time priority.
For example, if the inside bid consists of two market makers' bids and
a NAqcess limit order, and the market makers' bids were received before
the NAqcess limit order, the first two incoming market orders would be
delivered to the market makers and subject to potential rejection
within 20 seconds, rather than delivered to the limit order for
immediate automatic execution. The Commission seeks comment on whether
limit orders priced equal to the inside dealer quote should be given
priority over market maker quotations, the implications of such a rule,
and the relative costs and benefits of such a rule, particularly given
that orders against market makers are delayed for 20 seconds but are
executed immediately if matched with NAqcess limit orders;
(6) The proposal would limit the maximum order size for market
orders to 1,000 shares (depending on certain trading characteristics of
the security). For limit orders, the maximum order size would be 1,000
shares for all securities, except for limit orders in Nasdaq 100
securities for which the maximum limit order size would be 3,000
shares. The Commission seeks comment on the appropriate maximum order
size for NAqcess limit orders, and whether different thresholds should
be established for different Nasdaq securities. Further, the Commission
notes that the Commission's recent proposal concerning order execution
obligations generally would require display of limit orders of 10,000
shares or less; the Commission requests comment on the interaction
between this aspect of the Commission's proposal and the NASD's
proposal;
(7) The proposed NAqcess rules would limit access to the system to
agency orders entered by member firms on behalf of public customers.
Generally, the proposal would exclude: (a) accounts of persons
associated with any member firm, and (b) the immediate family of any
person associated with a member. The Commission is interested in
commenters' views on the appropriateness of these exclusions.
Specifically, the Commission requests comment on: (a) whether
proprietary market and limit orders should be allowed or,
alternatively, whether only proprietary limit orders should be allowed;
(b) whether orders from the immediate family of members should be
permitted; and (c) whether orders from non-member broker-dealers (e.g.,
options market makers and UTP specialists) to member broker-dealers
should be permitted;
(8) Under the proposal, any firm holding a protectible customer
limit order would be required to execute contemporaneously (i.e.,
within 60 seconds of the trade report), up to the size of the reported
transaction, the customer limit order at the limit order price if an
inferior-priced execution is reported in that security. The Commission
requests comment on the appropriateness of this time period;
(9) The NASD's proposal includes Rules of Fair Practice that
generally would prohibit a member from trading at a price inferior to a
viewable NAqcess limit order and require that orders held outside of
NAqcess be provided price protection substantially equivalent to that
which NAqcess orders would have.
[[Page 63100]]
Under the proposal, for each security, only market makers in that
security will be able to see the full limit order file; all other
members are limited to viewing the top of the file. The Commission
requests comment on whether there should be an exception to the NASD's
price protection rule for block trades. In addition, the Commission
requests comment on whether full file display of the NAqcess limit
order file should be broadened and, if so, to what extent; and
(10) The Commission requests comment on whether the NASD's
proposal, and in particular the amendments to the Rules of Fair
Practice, would result in any burdens on competition, and if so, the
extent of such burdens and whether they are necessary and appropriate
in furtherance of the Act.
Persons making written submissions should file six copies thereof
with the Secretary, Securities and Exchange Commission, 450 Fifth
Street, N.W., Washington, D.C. 20549. Copies of the submission, all
subsequent amendments, all written statements with respect to the
proposed rule change that are filed with the Commission, and all
written communications relating to the proposed rule change between the
Commission and any person, other than those that may be withheld from
the public in accordance with the provisions of 5 U.S.C. Sec. 552, will
be available for inspection and copying in the Commission's Public
Reference Room. Copies of the filing will also be available for
inspection and copying at the principal office of the NASD. All
submissions should refer to the file number SR-NASD-95-42 and should be
submitted by January 16, 1996.
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.34
\34\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Secretary.
Exhibit A--Rules of Operation and Procedures for the NAqcess System
I. Definitions
The terms used in this Section shall have the same meaning as those
defined in the Association's By-Laws and Rules of Fair Practice, unless
otherwise specified.
A. The term ``NAqcess'' shall mean the limit order and market order
delivery and execution system owned and operated by The Nasdaq Stock
Market, Inc. (a wholly owned subsidiary of the National Association of
Securities Dealers, Inc.).
B. The term ``NAqcess participant'' shall mean either a market
maker or order entry firm registered for participation in NAqcess.
C. The term ``NAqcess eligible security'' shall mean any Nasdaq
National Market or Nasdaq SmallCap equity security.
D. The term ``open quote'' shall mean a market maker's quotation
price and size (up to its designated exposure limit) in an eligible
security against which orders may be executed through the NAqcess
system during normal market hours, as specified by the NASD. For the
purposes of these Rules, a market maker has a ``closed quote'' when its
exposure limit in NAqcess has been exhausted or it has been deemed
``closed'' pursuant to Section IV. A. 9 below.
E. The term ``NAqcess market maker'' shall mean a member of the
Association that is registered as a Nasdaq market maker pursuant to the
requirements of Schedule D to the NASD By-Laws and as a market maker in
one or more NAqcess eligible securities.
F. The term ``NAqcess order entry firm'' shall mean a member of the
Association that is registered as an order entry firm for participating
in NAqcess which permits the firm to enter agency orders of limited
size for delivery to and execution against NAqcess market makers and
customer limit orders in NAqcess that are included in the inside
market.
G. The term ``agency order'' shall mean an order from a public
customer that is entered by the NAqcess order entry firm or NAqcess
market maker on an agency basis.
An order will not be considered an agency order if it is for any
account of a person associated with any member firm or any account
controlled by such an associated person. An order will not be
considered an agency order if it is for any account of a member of the
``immediate family'' (as that term is defined in the NASD Free-Riding
and Withholding Interpretation, Article III, Section 1 of the Rules of
Fair Practice) of an associated person who has physical access to a
terminal capable of entering orders into NAqcess.
H. The term ``directed order'' shall mean an order entered into
NAqcess and directed to a particular NAqcess market maker or an order
entered by a NAqcess market maker that is self-directed. Each market
maker has the ability to select order entry firms from which it will
accept directed orders.
I. The term ``non-directed order'' shall mean an order entered into
NAqcess and not directed to any particular market maker, or a directed
order that has been directed to a market maker that has not identified
the order entry firm as one from which it will accept directed orders,
or a directed order sent to a firm that is not registered as a market
maker in that security.
J. The term ``limit order'' shall mean an order entered into
NAqcess that is a priced order.
K. The term ``marketable limit order'' shall mean a limit order
that, at the time it is entered into NAqcess, if it is a limit order to
buy, is priced at the current inside offer or higher, or if it is a
limit order to sell, is priced at the inside bid or lower.
L. The term ``executable limit order'' shall mean a limit order
that, at the time a limit order, market order, or marketable limit
order on the opposite side of the market is entered, is either included
in the inside market or is equal in price to the inside market and has
time priority over other limit orders or dealer quotations included in
the inside market.
M. The term ``marker order'' shall mean a limit order for a market
maker's principal account that is a part of a contemporaneously
executed transaction that the firm is engaged in for the benefit of one
or more customers.
N. The term ``takeout order'' shall mean an order entered by an
NASD member firm, acting as principal or as agent, that executes
against NAqcess limit orders viewable by that firm.
O. The term ``inside market'' shall mean the best dealer bid, UTP
exchange bid, or NAqcess limit order(s) to buy and the best dealer
offer, UTP exchange offer or NAqcess limit order(s) to sell, as the
case may be, displayed by Nasdaq.
P. The term ``UTP exchange'' shall mean any registered national
securities exchange that has unlisted trading privileges in Nasdaq
securities.
Q. The term ``matched or crossed file'' shall mean the entry of:
(1) a bid quotation by a market maker equal to or greater than a limit
order to sell resident in the NAqcess file in the same security; or (2)
an offer quotation by a market maker equal to or less than a limit
order to buy resident in the NAqcess file in the same security.
R. The term ``maximum market order size'' shall mean the maximum
size of individual market orders for a NAqcess eligible security that
may be entered into or executed through NAqcess. The maximum market
order size for each security shall be advertised in the system and
published from time to time by the Association. In establishing the
maximum market order size for each Nasdaq National Market security, the
Association generally will give
[[Page 63101]]
consideration to the average daily non-block volume, bid price, and
number of market makers for each security. Maximum market order size
for Nasdaq National Market securities shall be 200, 500 or 1,000
shares, depending upon the trading characteristics of the
securities.1 These sizes may be adjusted on an issue by issue
basis, depending upon trading characteristics of the issue and other
relevant factors as determined by the Association. Maximum market order
size for Nasdaq SmallCap securities shall be 500 shares.
\1\ The applicable maximum market order size for each Nasdaq
National Market security is determined generally by the following
criteria:
(i) a 1,000 share maximum market order size shall apply to
Nasdaq National Market securities with an average daily non-block
volume of 6,000 shares or more a day, a bid price of less than or
equal to $100, and three or more market makers;
(ii) a 500 share maximum market order size shall apply to Nasdaq
National Market securities with an average daily non-block volume of
2,000 shares or more a day, a bid price of less than or equal to
$150, and two or more market makers; and
(iii) a 200 share maximum market order size shall apply to
Nasdaq National Market securities with an average daily non-block
volume of less than 2,000 shares a day, a bid price of less than or
equal to $250, and that have two or more market makers.
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S. The term ``maximum limit order size'' shall mean the maximum
size of a limit order for a security that may be entered into or
matched through NAqcess. The maximum limit order size for Nasdaq
National Market securities shall be 1,000 shares for each tier of
Nasdaq National Market securities, except for the securities that
comprise the Nasdaq 100 Index,2 which shall have a maximum limit
order size of 3,000 shares. Maximum limit order size for Nasdaq
SmallCap securities shall be 1,000 shares.
\2\ The Nasdaq 100 Index is an index comprised of many of the
largest capitalized issues quoted in the Nasdaq National Market. The
securities that make up the Nasdaq 100 are changed from time to time
and The Nasdaq Stock Market publishes notice of such changes as they
occur.
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T. The term ``exposure limit'' shall mean the number of shares of a
NAqcess eligible security specified by a NAqcess market maker that it
is willing to have executed for its account by orders entered into
NAqcess on either side of the market.
U. The term ``minimum exposure limit'' for a security shall mean an
exposure limit equal to the maximum market order size for that
security.
V. The term ``automated quotation update facility'' shall mean the
facility in the NAqcess system that allows the system to automatically
refresh a market maker's quotation in any security that the market
maker designates when the market maker's exposure limit has been
exhausted. The facility will update: (1) either the bid or the offer
side of the quote using a quotation interval designated by the market
maker, depending upon the side of the market on which the execution has
occurred and refresh the market maker's exposure limit; or (2) close
the market maker's quote for five minutes, within which time the market
maker shall update its quote or be placed in a suspended state for 20
days.
W. The term ``Automated Confirmation Transaction service''
(``ACT''), for purposes of the NAqcess rules, shall mean the automated
system owned and operated by The Nasdaq Stock Market, Inc. which
accommodates trade reporting of transactions executed through NAqcess
and submits locked-in trades to clearing.
II. NAqcess Participant Registration
A. All members participating in NAqcess shall register and be
authorized as NAqcess market makers and/or order entry firms.
Registration as a NAqcess participant shall be conditioned upon the
member's initial and continuing compliance with the following
requirements: (1) membership in a clearing agency registered with the
Securities and Exchange Commission which maintains facilities through
which NAqcess compared trades may be settled; or entry into a
correspondent clearing arrangement with another member that clears
trades through such clearing agency; (2) registration as a market maker
(if applicable) in Nasdaq pursuant to Schedule D of the NASD By-Laws
and compliance with all applicable rules and operating procedures of
the Association and the Securities and Exchange Commission; (3)
maintenance of the physical security of the equipment located on the
premises of the member to prevent the unauthorized entry of orders or
other data into NAqcess or Nasdaq; and (4) acceptance and settlement of
each trade for which it is responsible that is executed through the
facilities of the NAqcess service, or if settlement is to be made
through another clearing member, guarantee of the acceptance and
settlement of such identified NAqcess trades by the clearing member on
the regularly scheduled settlement date.
B. Upon effectiveness of the member's registration to participate
in NAqcess, participants may commence activity within NAqcess for entry
and/or execution of orders, as applicable, and their obligations as
established in this rule will commence.
C. Pursuant to Schedule D to the NASD By-Laws, participation as a
NAqcess market maker is required for any Nasdaq market maker registered
to make a market in a Nasdaq National Market security. A market maker
in a Nasdaq SmallCap security may withdraw from and reenter NAqcess at
any time, and without limitations, during the operating hours of the
service.
D. Each NAqcess participant shall be under a continuing obligation
to inform the Association of noncompliance with any of the registration
requirements set forth above.
III. Operating Hours of NAqcess
The operating hours of NAqcess will be the normal market hours
specified for The Nasdaq Stock Market.
IV. Participant Obligations in NAqcess
A. Market Makers
1. A NAqcess market maker shall commence participation in NAqcess
by initially contacting the Market Operation Center to obtain
authorization for market making in particular Nasdaq securities and
identifying those terminals on which the NAqcess trade information is
to be displayed. Thereafter, on-line registration on a security-by-
security basis is permissible, consistent with the requirements of
Schedule D to the NASD By-Laws.
2. Participation as a NAqcess market maker obligates the firm, upon
presentation of a market order or marketable limit order through the
service, to execute such order as provided in Section V. A. 5. below.
NAqcess market makers are not permitted to decline orders directed to
the firm pursuant to a directed order arrangement acknowledged by the
market maker. The system will transmit to the market maker on the
Nasdaq Workstation screen and printer, if requested, or through a
computer interface, as applicable, an execution report generated
following each execution.
3. For each NAqcess eligible security in which a market maker is
registered, the market maker shall enter into NAqcess its exposure
limit. For a Nasdaq National Market security, that limit shall be any
amount equal to or larger than the minimum exposure limit for the
particular security. If no exposure limit is entered for a Nasdaq
National Market security, the firm's exposure limit will be either the
default size selected by the particular market maker or the minimum
exposure limit. ``Default size'' shall mean an exposure limit greater
than the minimum exposure limit that may be selected by a market maker
for individual securities or for all securities in which it makes a
market.
4. A NAqcess market maker may elect to use the automated quotation
update
[[Page 63102]]
facility in one or more securities in which it is registered. The
facility will update the market maker's quotation automatically by a
quotation interval designated by the market maker, once its exposure
limit in the security has been exhausted. The facility will update the
market maker's quotation in either the bid or the offer side of the
market by the interval designated and will reestablish the market
maker's displayed size and either the default size or the minimum
exposure limit; or the facility will close the market maker quote for
five minutes.
5. Matched or crossed file. If a market maker's quotation change
matches or crosses a limit order residing in the NAqcess limit order
file, the system will automatically provide a notification to the
market maker that informs the market maker of its obligation to protect
all limit orders residing in the NAqcess file that would be affected by
the quotation change. If the market maker enters the matching or
crossing quotation change after this notification, limit orders in the
file for the particular security will be automatically executed against
the matching or crossing market maker, provided however, that if the
number of shares in the limit order file that would be matched or
crossed is greater than five times the maximum market order size for
that particular security, or if the quotation change matches and
crosses multiple price levels, the quotation change will be rejected.
To effect such quotation change, the market maker first must manually
enter a takeout order for the affected orders in the file prior to re-
entering its quotation update.
6. The market maker may terminate its obligation by keyboard
withdrawal from NAqcess at any time. However, the market maker has the
specific obligation to monitor its status in NAqcess to assure that a
withdrawal has in fact occurred. Except as otherwise permitted by
Section 70 of the Uniform Practice Code regarding the Association's
authority to declare clearly erroneous transactions void, (``UPC
Section 70''), any transaction occurring prior to the effectiveness of
the withdrawal may remain the responsibility of the market maker. In
the case of a Nasdaq SmallCap security, a market maker whose exposure
limit is exhausted will be deemed to have withdrawn from NAqcess and
may reenter at any time. In the case of a Nasdaq National Market
security, a market maker whose exposure limit is exhausted will have a
closed quote in Nasdaq and NAqcess and will be permitted a standard
grace period of five minutes within which to take action to restore its
exposure limit, if the market maker has not authorized use of the
automated quotation update facility. A market maker that fails to renew
its exposure limit in a Nasdaq National Market security within the
allotted time will be deemed to have withdrawn as a market maker.
Except as provided in subsection 7 below, a market maker that withdraws
from a Nasdaq National Market security may not re-register in NAqcess
as a market maker in that security for twenty (20) business days.
7. Notwithstanding the provisions of subsection 6 above, (i) a
market maker that obtains an excused withdrawal pursuant to Part V of
Schedule D to the NASD By-Laws prior to withdrawing from NAqcess may
reenter NAqcess according to the conditions of its withdrawal; and (ii)
a market maker that fails to maintain a clearing arrangement with a
registered clearing agency or with a member of such an agency, and is
thereby withdrawn from participation in ACT and NAqcess for Nasdaq
National Market securities, may reenter NAqcess after a clearing
arrangement has been reestablished and the market maker has complied
with ACT participant requirements, provided however, that if the
Association finds that the ACT market maker's failure to maintain a
clearing arrangement is voluntary, the withdrawal of quotations will be
considered voluntary and unexcused pursuant to Schedule D and these
rules.
8. In the event that a malfunction in the market maker's equipment
occurs rendering on-line communications with the NAqcess service
inoperable, the NAqcess market maker is obligated to immediately
contact the Market Operations Center by telephone to request a closed
quote status from NAqcess. For Nasdaq securities, such request must be
made pursuant to the requirements of Part V, Schedule D to the NASD By-
Laws. If the closed quote status is granted, Market Operations
personnel will enter such status notification into NAqcess from a
supervisory terminal. Such manual intervention, however, will take a
certain period of time for completion and, unless otherwise permitted
by the Association pursuant to its authority under UPC Section 70, the
NAqcess market maker may continue to be obligated for any transaction
executed prior to the effectiveness of its closed quote.
B. Order Entry
1. Only market and limit agency orders may be entered in NAqcess by
the NAqcess order entry firm through either its Nasdaq Workstation or
computer interface. The system will transmit to the order entry firm on
the Nasdaq Workstation screen and printer, if requested, or through a
computer interface, as applicable, an execution report generated
following each execution. NAqcess market makers may enter limit agency
orders in NAqcess for any NAqcess eligible security, but may not enter
agency market orders or marketable limit orders in securities in which
they make markets, unless such orders are self-directed. As a limited
exception to the prohibition of the entry of proprietary orders into
NAqcess, NAqcess market makers may place marker orders into NAqcess.
The benefit of any such marker order execution must be passed
immediately to one or more customer limit orders held by the firm
placing the marker order. Marker orders may not be placed with respect
to customer limit orders held by the firm that exceed the maximum limit
order size permitted by these rules.
2. NAqcess will accept both market and limit agency orders of
appropriate size for execution. Agency orders may be directed to a
specific NAqcess market maker, self-directed by the NAqcess market
maker, or may be non-directed, thereby resulting in execution against
the next available NAqcess market maker. If an order is directed to a
market maker by an order entry firm from which it has not agreed to
accept direct orders, the order will be executed on a non-directed
basis.
3. Only agency orders no larger than the maximum market and limit
order sizes may be entered by a NAqcess order entry firm into NAqcess
for execution against an NAqcess market maker or against an executable
limit order. Orders in excess of the maximum order sizes may not be
divided into smaller parts for purposes of meeting the size
requirements for orders entered into NAqcess. All orders based on a
single investment decision that are entered by a NAqcess order entry
firm for accounts under the control of associated persons or public
customers, whether acting alone or in concert with other associated
persons or public customers, shall be deemed to constitute a single
order and shall be aggregated for determining compliance with the
maximum order size limits. Orders entered by the NAqcess order entry
firm within any five-minute period in accounts controlled by associated
persons or public customers, acting alone or in concert with other
associated persons or public customers, shall be presumed to be based
on a single investment decision. An associated person or customer shall
be deemed to control an account if the account is his or her personal
account or an account in
[[Page 63103]]
which he or she has a beneficial interest; the person exercises
discretion over the account; the person has been granted a power of
attorney over the account; or the account is the account of an
immediate family member as that term is defined in the Board of
Governors Interpretation on Free-Riding and Withholding, Article III,
Section 1 of the NASD Rules of Fair Practice.
4. No order will be considered an agency order from a public
customer if it is for any account of a person associated with any
member firm or any account controlled by such an associated person. No
order will be considered an agency order from a public customer if it
is for any account of a member of the ``immediate family'' (as that
term is defined in the NASD Free-Riding and Withholding Interpretation,
Article III, Section 1 of the Rules of Fair Practice) of an associated
person who has physical access to a terminal capable of entering orders
into NAqcess.
5. No member or person associated with a member shall utilize
NAqcess for the execution of agency orders in a SmallCap security in
which the member is a Nasdaq market maker but is not a NAqcess market
maker.
6. NAqcess will accept the following types of agency orders during
normal market hours: (a) day orders; (b) good-till-canceled (``GTC'');
and (c) good till date (``GTD'').
V. Execution of NAqcess Orders
A. General Execution Procedures: Orders in Nasdaq equity securities
entered into NAqcess may be directed or non-directed. Non-directed
market orders and non-directed marketable limit orders will be
processed according to the procedures established below. Non-directed
odd-lot orders that are market orders or marketable limit orders will
be automatically executed in NAqcess against the next available market
maker at the inside market and execution reports will be delivered to
the order entry firm and the market maker.
1. Entry of Limit Orders: Limit orders may be entered into NAqcess
by order entry firms and by market makers up to the maximum limit order
size allowed for a particular security. Limit orders priced away from
the Nasdaq inside bid or offer (as the case may be) as well as limit
orders consolidated in the inside market will be stored in the NAqcess
limit order file. Limit orders in securities priced at $10 or more
shall be priced in increments of an eighth or more; limit orders in
securities that are priced at under $10 may be placed in increments of
a sixteenth or less depending upon the dealer quotation increments
permitted.
2. Display of NAqcess Limit Orders: (a) Consolidated Display of
Limit Orders In Inside Market: If a NAqcess limit order to buy or sell
for 100 shares or more is better than the best dealer bid or offer, the
limit order to buy or sell will be displayed in the Nasdaq inside
market. Such display will contain the limit order price, size (which
shall be aggregated if two or more limit orders are at the same best
price) and an indicator to note that the inside market consists of a
limit order rather than a market maker or UTP exchange quotation. If a
NAqcess limit order of 100 shares or more is at the same price as the
best dealer bid or offer, the size displayed in the inside market will
be an aggregation of any same-priced limit orders and a single dealer
quote at the best price.
(b) Full Limit Order File Display: All Nasdaq market makers in a
particular security may request via Nasdaq Workstations a display of
all limit orders in such security entered in the NAqcess limit order
file. Such displays will be available on a query basis only to a
registered market maker in a particular security.
3. Execution of Limit Orders: A limit order that matches or crosses
a limit order on the opposite side of the market will be automatically
executed against the matching or crossing order when such orders are at
the inside market or better, and have priority over the dealer
quotation. The priority rules for limit order interaction shall be that
orders that are best in price shall be executed against each other
first. If two or more orders are at the same price on the same side of
the market, then the order that was received first in time shall be
accorded priority over other orders at the same price. Limit orders
that cross each other in price shall be executed at the price of the
order that entered the file first. A limit order matches a limit order
on the file when: the limit orders are consolidated in the inside
market on Nasdaq; are on opposite sides of the market; and are equal in
price. A limit order crosses a limit order on the file when: both limit
orders are either consolidated in the inside market or better than the
inside market; are on opposite sides of the market from each other; and
the subsequent limit order is at a superior price to the existing limit
order (i.e., the sell (buy) limit order is priced below (above) a limit
order to buy (sell)). Execution of limit orders will occur up to the
size of the initial limit order or the subsequent limit order,
whichever is smaller, and without the participation of a market maker.
The unexecuted balance of a limit order is entered into the NAqcess
file for subsequent matching, unless such balance is less than 100
shares, in which case the balance is automatically executed against the
next available market maker, if equal to the inside quotation. If there
is a limit order at the same price as the best dealer quotation (i.e.,
if a limit order to buy is the same as the best dealer bid, or a limit
order to sell is the same as the best dealer offer), the order or quote
that has time priority shall be matched against the incoming limit
order.
4. Takeouts of Limit Orders: Any NASD member firm, acting as
principal or as agent, may enter into NAqcess an order or orders that
execute(s) any limit order(s) consolidated in the inside market or
otherwise displayed in the NAqcess limit order file. Such orders shall
be known as ``takeout'' orders. A takeout order may be for any size up
to the aggregate amount of shares displayed in the NAqcess limit order
file at a particular price. Takeout orders must be executed against
limit orders on the opposite side of the market in order of price and
time. A firm entering a takeout order for limit orders at multiple
prices may enter a single takeout order at a price either at or above
or below the NAqcess limit orders, as the case may be, and each limit
order will be executed at each such price. Takeout orders do not reduce
a firm's exposure limit.
5. Entry and Execution of Market Orders: (a) Market orders up to
the maximum market order size for NAqcess eligible security may be
entered into NAqcess. If at the time a market order is entered into
NAqcess there is a limit order on the opposite side of the market that
resides in the NAqcess limit order file and is reflected in the inside
market as the best bid or offer, the incoming market order will be
automatically executed against the limit order at the limit order price
without the participation of a market maker. If a market order is not
fully executed against the limit order file, the balance of such market
order will be treated as any other market order as set forth in
subparagraph (b) below, provided that if the balance of the market
order is odd-lot size, the balance will be automatically executed
against the next available market maker at the inside quotation. If
there is a limit order consolidated in the inside market at the same
price as a dealer bid or offer (i.e., if a limit order to buy is the
same as the best dealer bid, or a limit order to sell is the same as
the best dealer offer), the order or quote that has time priority
[[Page 63104]]
shall be matched against the incoming market order.
(b) If there is no limit order residing in NAqcess that has been
consolidated in the inside market on the opposite side of the market
from the market order, each market order will be assigned to a market
maker at the inside market and will be executed against the next
available market maker at the current inside market after a display
period of 15-seconds. The market maker to which a market order is
displayed may decline the market order within the 15-second period if
the market maker has contemporaneously executed another transaction and
is in the process of updating its quotation pursuant to SEC Rule 11Ac1-
1. If a market order or a marketable limit order is declined by a
market maker, the order is returned to the system for distribution to
the next available market maker. If that market maker is at the same
price level as the first market maker who declined the order, the
second market maker has 15 seconds to react to the order. If the
originally declined order is re-presented to a market maker at a price
level different from its original presentation(s), the order is
automatically executed at that price level without any market maker
ability to decline.
(c) If the NAqcess limit order file does not have any executable
limit orders at the time a directed market order is entered, directed
market orders will be automatically executed against the directed order
market maker without a 15-second decline capability. Directed limit
orders that are not matched by incoming limit or market orders will be
automatically executed against the directed order market maker when the
inside market is changed to match the directed limit order price.
Directed odd-lot orders (orders of less than 100 shares) that are
market orders or marketable limit orders also will be automatically
executed against the directed order market maker. Non-directed odd-lot
orders that are market orders or marketable limit orders will be
automatically executed against the next available market maker at the
current inside market. An odd-lot limit orders that is not executable
at time of entry will be stored and executed against the best dealer
bid or offer, as the case may be, when such quotation reaches the limit
order price.
6. Entry and Execution of A Marketable Limit Order: Marketable
limit orders that meet the maximum market order size requirements will
be accepted and treated as market orders. Marketable limit orders
greater than the maximum market order size will be returned to the
order entry firm for handling outside of NAqcess.
7. NAqcess Opening Procedures: NAqcess will permit the entry of
limit orders and market orders outside of normal market hours, except
that market orders will not be accepted between 4:00 and 6:00 p.m.
Orders entered at such times will not be executed but will be stored
for matching and execution at the next market opening. NAqcess permits
the entry of such orders between 4:01 p.m. to 6:00 p.m. and 8:00 a.m.
to 9:28 a.m. (Orders entered from 9:28 to 9:30 will be stored and
handled according to normal market procedures after the opening
procedures are concluded.)
Matching and execution at the NAqcess opening will occur according
to the following procedures:
At 9:28 a.m., NAqcess will stop accepting orders for execution in
the NAqcess file for opening purposes. At 9:30 a.m., NAqcess will
commence execution procedures for opening orders in NAqcess by first
ranking and matching limit orders in NAqcess in sequence of the highest
price buy order against the lowest price sell order. When all available
limit orders are matched and executed, market orders on a time priority
basis will be matched and executed against any remaining limit orders
in the NAqcess file within the inside quotation at the limit order
price(s). Any remaining market limit orders will be stored in the
NAqcess file. Any remaining orders will be subject to normal order
execution processes.
VI. Clearance and Settlement
All transactions executed in NAqcess shall be transmitted to the
National Securities Clearing Corporation to be cleared and settled
through a registered clearing agency using a continuous net settlement
system.
VII. Obligation to Honor System Trades
If a trade reported by a NAqcess participant, or clearing member
acting on its behalf, is reported by NAqcess to clearing at the close
of any trading day, or shown by the activity reports generated by
NAqcess as constituting a side of a NAqcess trade, such NAqcess
participant, or clearing member acting on its behalf, shall honor such
trade on the scheduled settlement date.
VIII. Compliance With Procedures and Rules
Failure of a NAqcess participant or person associated with a
NAqcess participant to comply with any of the rules or requirements of
NAqcess may be considered conduct inconsistent with high standards of
commercial honor and just and equitable principles of trade, in
violation of Article III, Section 1 of the Rules of Fair Practice. No
member shall effect a NAqcess transaction for the account of a
customer, or for its own account, indirectly or through the offices of
a third party, for the purpose of avoiding the application of these
rules. Members are precluded from doing indirectly what is directly
prohibited by these rules. All entries in NAqcess shall be made in
accordance with the procedures and requirements set forth in the
NAqcess User Guide. Failure by a NAqcess participant to comply with any
of the rules or requirements applicable to NAqcess shall subject such
NAqcess participant to censure, fine, suspension or revocation of its
registration as a NAqcess market maker and/or order entry firm or any
other fitting penalty under the Rules of Fair Practice of the
Association.
IX. Termination of NAqcess Service
The Association may, upon notice, terminate NAqcess service to a
participant in the event that a participant fails to abide by any of
the rules or operating procedures of the NAqcess service or the
Association, or fails to pay promptly for services rendered.
Exhibit B--Interpretations Related to Member Firm Responsibilities
Regarding Orders in NAqcess
In its efforts to maximize the protection of investors and to
enhance the quality of the marketplace, the NASD and The Nasdaq Stock
Market, Inc. have developed a nationwide limit order protection, price
improvement, and market order handling facility of The Nasdaq Stock
Market. This nationwide facility is herein referred to as ``NAqcess''.
The NASD Board of Governors is issuing these Interpretations to the
Rules of Fair Practice to provide: (1) Customers the right to have
their orders entered and protected in NAqcess; and (2) member firm
provision of equivalent protection for limit orders held in a member
firm's proprietary limit order system. These Interpretations are based
upon a member firm's obligation to provide best execution to customer
orders under Article III, Section 1 of the Rules of Fair Practice and a
member firm's obligations in dealing with customers as principal or
agent to buy and sell at fair prices and charge reasonable commissions
or service charges under Article III, Section 4 of the Rules of Fair
Practice. Accordingly, it shall be deemed a violation of Article
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III, Section 1 of the Rules of Fair Practice for a member or a person
associated with a member to violate the following provisions:
1. Member Firm Obligation Regarding Investors' Directions on Order
Handling
NAqcess will provide individual investors with significant
opportunities to achieve limit order protection and price improvement.
The NASD recognizes that member firms operating as market makers also
operate trading systems which offer significant protection and
execution opportunities for customer limit orders. Accordingly, nothing
herein is intended to limit a member's ability to recommend use of its
own or another member firm's proprietary system for handling limit and
market orders where equivalent protection is afforded. In light of the
significant benefits offered to customers by the NAqcess system,
however, members must abide by the directions of its customers who
request that the firm enter their orders in NAqcess.
Further, nothing in this Interpretation requires a member firm to
accept any or all customer limit orders. Member firms accepting limit
orders that are placed in NAqcess or otherwise may charge fair and
reasonable commissions, commission equivalents, or service charges for
such handling, provided that such commissions, commission equivalents,
or service charges do not violate Article III, Section 4 of the Rules
of Fair Practice. In no event, however, shall a member impose any fee
or charge that effectively operates as a disincentive to the entry of
orders in the nationwide facility and thereby interferes with the
investor's ability to choose order handling alternatives.
2. Equivalent Protection for Orders Held Outside of NAqcess
As a further adjunct to a member firm's best execution obligations,
the NASD Board of Governors has interpreted Article III, Section 1 of
the Rules of Fair Practice to require member firms that do not enter
customer limit orders into NAqcess, but hold such protectible orders in
their own proprietary system, to provide such orders with price
protection at least equivalent in substance to that which the order
would have received had the order been entered into NAqcess. For the
purposes of this Interpretation, a ``protectible limit order'' shall
mean a limit order that meets the maximum limit-order size criteria as
set forth in the Rules of Operation and Procedure for NAqcess at
Section I.S. For the purposes of this Interpretation, equivalent price
protection shall mean:
A. Print Protection
If a transaction in a Nasdaq security is reported via the Automated
Confirmation Transaction Service (``ACT'') at a price inferior to the
price of customer limit order(s) that the firm is holding (i.e., if the
reported price is a price lower than a buy limit order or higher than a
sell limit order being held by the firm), the firm holding the limit
order(s) is required on a contemporaneous basis to execute the limit
order(s) at the limit price(s) up to the size of the reported
transaction.
B. Matching Limit Orders
If the firm holds a customer buy (sell) limit order in its
proprietary limit order file and that limit order matches a sell (buy)
limit order in NAqcess, the firm holding the limit order must either
provide its customer with an immediate execution at the limit order
price or must immediately direct the order to NAqcess. A limit order
held by a firm would match a limit order in NAqcess when the limit
order in NAqcess is at the same price or is priced lower than the
firm's customer's limit order to buy or higher than the firm's customer
limit order to sell (``offsetting limit orders'').
C. Matching Limit Order Interaction Within A Firm's File
If the firm holds two or more offsetting customer limit orders
within its own proprietary file, the firm must execute the offsetting
limit orders.
D. Interaction Between Limit and Market Orders Held Within A Firm's
File
While holding a customer limit order that is priced equal to or
better than the best bid or offer in the security disseminated in
Nasdaq, if a firm accepts customer market orders for automated
execution against the best bid or offer in the security disseminated in
Nasdaq, the firm, pursuant to its obligation set forth in the
Interpretation to the Rules of Fair Practice, Article III, Section 1,
(the so-called ``Manning Interpretation''), must first permit the
market orders to execute against any applicable limit orders it holds
before the firm may execute the market orders for its own account.
E. Examples of Equivalent Protection
The NASD Board of Governors has provided the following examples to
further explain a member firm's equivalent protection obligation for
orders held outside of NAqcess:
Print Protection The best dealer bid and offer in Nasdaq (``the
inside price'') is 20 bid-20\1/4\ offer. Firm ABCD holds a customer
limit order of 1,000 shares to buy at 20\1/8\ in its own proprietary
file. Firm MNOP reports a transaction in the subject security via ACT,
disseminating a price of 20\1/16\ for 500 shares. Contemporaneous with
the dissemination of the trade report, firm ABCD is required to provide
an execution of its customer limit order for at least 500 shares at
20\1/8\.
Matching Limit Orders The inside price is 20 bid-20\1/4\ offer.
NAqcess is displaying a 1,000 share customer limit order to buy at
20\1/8\ for customer X. Firm ABCD thereafter receives from customer Y a
1,000 share limit order to sell at 20\1/8\ that the firm ABCD retains
for handling outside of NAqcess. Upon receipt of the limit order, firm
ABCD must execute customer Y's limit order for 1,000 shares at 20\1/8\.
Matching Limit Order Interaction Within A Firm's File. The inside
price is the same as above. Firm ABCD holds a customer limit order to
buy 1,000 shares at 20\1/8\. Firm ABCD thereafter receives a customer
limit order to sell 1,000 shares at 20\1/8\. Firm ABCD must match the
orders and execute the trade.
Interaction Between Limit and Market Orders Held Within A Firm's
File. The inside price is the same as above. Firm ABCD holds a customer
limit order to buy 1,000 shares at 20\1/8\. Firm ABCD thereafter
receives a customer market order to sell 1,000 shares. Firm ABCD must
match the two orders and execute the trade at 20\1/8\. Similarly, if
the limit order to buy were priced at 20, the firm would have to
execute the market order against the limit order at 20.
Price Protection for NAqcess Limit Orders, Rules of Fair Practice,
Article III, Section [XX]
No member firm shall execute an order as principal or as agent at a
price inferior to any limit order(s) viewable in NAqcess to the member
firm, provided however, that a member firm executing a transaction that
is larger than the limit order(s) viewable in NAqcess at an inferior
price must contemporaneously satisfy the limit order(s) viewable in
NAqcess. An ``inferior price'' means an execution price that is lower
than a buy limit order or higher than a sell limit order that is
viewable in NAqcess. The term ``limit orders viewable in NAqcess''
shall mean those orders that the member firm is able to view either as
consolidated in the Nasdaq inside market or as reflected in the Full
Limit Order File Display as the firm is
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authorized to view under the Rules of Operation and Procedure.
[FR Doc. 95-29950 Filed 12-7-95; 8:45 am]
BILLING CODE 8010-01-P
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